TOPIC 1

(CHAPTER 9)

Financial Planning and Analysis: The

Master Budget
Definition and Purposes of Budget
Budget 1. Planning
a detailed plan, expressed in 2. Facilitating
quantitative terms, that specifies Communication and
how resources will be acquired Coordination
and used during a specified
period of time. 3. Allocating Resources
4. Controlling Profit and
Operations
5. Evaluating
Performance and
Providing Incentives

9-2
Types of Budgets
Detail
Budget
Detail
Budget
Detail

Production
Budget
Master
Budget
Covering all
phases of
a companys
operations.

9-3
 Types of Budgets
Income
Statement

Budgeted
Financial
Statements

Balance Statement of
Sheet Cash Flows
9-4
 Sales of Services or Goods

Ending
Inventory Production
Budget Budget
Work in Process
and Finished
Goods

Ending Direct Direct Selling and

Overhead
Inventory Materials Labor Administrative
Budget Budget Budget Budget
Budget
Direct Materials

Cash Budget
Budgeted Income
Statement
Budgeted Balance
Sheet
Budgeted Statement
of Cash Flows
9-5
OPERATING BUDGETS

1. Sales budget
2. Production budget
3. Direct materials purchases budget
4. Direct labor budget
5. Overhead budget
6. Selling & administrative budget
7. Ending finished goods inventory budget
8. Cost of goods sold budget

6
 Sales Budget
Breakers, Inc. is preparing budgets for the quarter ending June 30.

Budgeted sales for the next five months are:

April 20,000 units
May 50,000 units
June 30,000 units
July 25,000 units
August 15,000 units.

The selling price is $10 per unit.

 Sales Budget
April May June

Budgeted
sales (units) 20,000 50,000 30,000
Selling price
per unit $ 10 $ 10 $ 10
Total
Revenue $ 200,000 $ 500,000 $ 300,000
 Production Budget

Sales Production
Budget Budget

Production must be adequate to meet budgeted

sales and provide for sufficient ending inventory.
 Production Budget
The management of Breakers, Inc. wants ending inventory to
be equal to 20% of the following months budgeted sales in
units.

On March 31, 4,000 units were on hand.

Units to be produced = Expected unit sales + Units in ending inventory

Units in beginning inventory
Production Budget
April May June
Sales in units 20,000
Add: desired
end. inventory
Total needed
Less: beg.
inventory
Units to be
started

From sales
budget
 Production Budget
April May June
Sales in units 20,000
May sales 50,000 units
Add: desired Desired percent 20%
end. inventory 10,000 Desired inventory 10,000 units
Total needed 30,000
Less: beg.
inventory
Units to be
started
 Production Budget
April May June
Sales in units 20,000
Add: desired
end. inventory 10,000
Total needed 30,000
Less: beg.
inventory 4,000
Units to be
started 26,000

March 31
ending inventory
 Production Budget
April May June
Sales in units 20,000 50,000
Add: desired
end. inventory 10,000 6,000
Total needed 30,000 56,000
Less: beg.
inventory 4,000 10,000
Units to be
started 26,000 46,000
 Production Budget
April May June
Sales in units 20,000 50,000 30,000
Add: desired
end. inventory 10,000 6,000 5,000
Total needed 30,000 56,000 35,000
Less: beg.
inventory 4,000 10,000 6,000
Units to be
started 26,000 46,000 29,000
 Direct-Material Budget
At Breakers, five kilo of material are required per unit of product.
Management wants materials on hand at the end of each month
equal to 10% of the following months production.
On March 31, 13,000 kilo of material are on hand. Material cost
$.40 per kilo.

Direct materials (DM) purchased = DM needed for production + DM

desired in ending inventory DM in beginning inventory
 Direct-Material Budget
April May June
Production in units 26,000 46,000 29,000
Materials per unit
Production needs
Add: desired
ending inventory
Total needed
Less: beginning
inventory
Materials to be
purchased

From our
production
budget
 Direct-Material Budget
April May June
Production in units 26,000 46,000 29,000
Materials per unit 5 5 5
Production needs 130,000 230,000 145,000
Add: desired
ending inventory
Total needed
Less: beginning
inventory
Materials to be
purchased
 Direct-Material Budget
April May June
Production in units 26,000 46,000
Materials per unit 5 5
Production needs 130,000 230,000
Add: desired
ending inventory 23,000
Total needed 153,000
Less: beginning
inventory
Materials to be
purchased

10% of the following

months production needs
 Direct-Material Budget
April May June
Production in units 26,000 46,000 29,000
Materials per unit 5 5 5
Production needs 130,000 230,000 145,000
Add: desired
ending inventory 23,000
Total needed 153,000
Less: beginning
inventory 13,000
Materials to be
purchased 140,000

March 31
inventory
 Direct-Material Budget
April May June
Production in units 26,000 46,000 29,000
Materials per unit 5 5 5
Production needs 130,000 230,000 145,000
Add: desired
ending inventory 23,000 14,500 11,500
Total needed 153,000 244,500 156,500
Less: beginning
inventory 13,000 23,000 14,500
Materials to be
purchased 140,000 221,500 142,000
 Direct-Material
July Production
Budget
Sales in units 25,000
Add: desired ending inventory
April 3,000
May June
Total units needed
Production in units 26,000 28,000
46,000 29,000
Less: beginning
Materials inventory 5
per unit 5,0005 5
Production
Productioninneeds
units 130,000 23,000
230,000 145,000
Add: desired
ending inventory 23,000 14,500 11,500
Total needed 153,000 244,500 156,500
Less: beginning
inventory 13,000 23,000 14,500
Materials to beJune Ending Inventory
July production in units 23,000
purchased 140,000 221,500 142,000
Materials per unit 5
Total units needed 115,000
Inventory percentage 10%
June desired ending inventory 11,500
 Direct-Labor Budget
At Breakers, each unit of product requires 0.1 hours
of direct labor.
Workers agreed to a wage rate of $8 per hour
Direct-Labor Budget
April May June
Production in units 26,000 46,000 29,000
Direct-labor hours
Labor hours required
Wage rate
Total direct-labor cost

From our
production
budget
 Direct-Labor Budget
April May June
Production in units 26,000 46,000 29,000
Direct-labor hours 0.10 0.10 0.10
Labor hours required 2,600 4,600 2,900
Wage rate
Total direct-labor cost
Direct-Labor Budget

April May June

Production in units 26,000 46,000 29,000
Direct-labor hours 0.10 0.10 0.10
Labor hours required 2,600 4,600 2,900
Wage rate $ 8 $ 8 $ 8
Total direct-labor cost $ 20,800 $ 36,800 $ 23,200
 Overhead Budget
Here is Breakers Overhead Budget for the quarter.
April May June

Indirect labor $ 17,500 $ 26,500 $ 17,900

Indirect material 7,000 12,600 8,600
Utilities 4,200 8,400 5,200
Rent 13,300 13,300 13,300
Insurance 5,800 5,800 5,800
Depreciation 8,200 9,400 8,200
$ 56,000 $ 76,000 $ 59,000
 Selling and Administrative Expense
Budget
At Breakers, variable selling and administrative expenses are
$0.50 per unit sold.
Fixed selling and administrative expenses are $70,000 per
month.
The $70,000 fixed expenses include $10,000 in depreciation
expense that does not require a cash outflow for the month.
Selling and Administrative Expense
Budget
April May June
Sales in units 20,000 50,000 30,000
Variable S&A rate
Variable expense
Fixed S&A
expense
Total expense
Less: noncash
expenses
Cash
disbursements
From our
Sales budget
Selling and Administrative Expense
Budget
April May June
Sales in units 20,000 50,000 30,000
Variable S&A rate $ 0.50 $ 0.50 $ 0.50
Variable expense $ 10,000 $ 25,000 $ 15,000
Fixed S&A
expense 70,000 70,000 70,000
Total expense $ 80,000 $ 95,000 $ 85,000
Less: noncash
expenses 10,000 10,000 10,000
Cash
disbursements $ 70,000 $ 85,000 $ 75,000
 Cash
Budget
Cash Receipts Budget
At Breakers, all sales are on account.
The companys collection pattern is:
70% collected in the month of sale,
25% collected in the month following the sale,
5% is uncollected.
The March 31 accounts receivable balance of $30,000 will be
collected in full.
 Cash Receipts Budget
April May June Total
Accounts rec. - 3/31 $ 30,000 $ 30,000
April sales*
70% x $200,000 140,000 140,000
25% x $200,000 $ 50,000 50,000
May sales*
70% x $500,000 350,000 350,000
25% x $500,000 $ 125,000 125,000
June sales*
70% x $300,000 210,000 210,000
Total cash collections $ 170,000 $ 400,000 $ 335,000 $ 905,000

* Taken from sales budget (slide no. 8)

Cash Disbursement Budget

Breakers pays $0.40 per kg for its materials.

One-half of a months purchases are paid for in the month of
purchase; the other half is paid in the following month.
No discounts are available.
The March 31 accounts payable balance is $12,000.
Cash Disbursement Budget
April May June Total
Accounts pay. 3/31 $ 12,000 $ 12,000
April purchases
50% x $56,000 28,000 28,000
50% x $56,000 $ 28,000 28,000
May purchases
50% x $88,600 44,300 44,300
50% x $88,600 $ 44,300 44,300
June purchases
50% x $56,800 28,400 28,400
Total cash payments
for materials $ 40,000 $ 72,300 $ 72,700 $ 185,000

140,000 kg $.40/kg = $56,000

* Taken from direct material budget
Cash Budget
(Collections and Disbursements)
Breakers:
Maintains a 12% open line of credit for $75,000.
Maintains a minimum cash balance of $30,000.
Borrows and repays loans on the last day of the month.
Pays a cash dividend of $25,000 in April.
Purchases $143,700 of equipment in May and $48,300 in June paid in
cash.
Has an April 1 cash balance of $40,000.
 From Cash
Cash Budget
Receipts Budget
(Collections and Disbursements)
April May June Total
Beginning cash balance $ 40,000
From Cash Disbursements Budget
Add: cash collections 170,000
Total cash available 210,000
Less: disbursements
From Direct Labor Budget
Materials 40,000
Direct labor 24,000 From Overhead Budget
Mfg. overhead 56,000
From Selling and Administrative
Selling and admin. 70,000
Expense Budget
Equipment purchase -
Dividends 25,000
Total disbursements 215,000 To maintain a cash
Excess (deficiency) of balance of $30,000,
Cash available over Breakers must borrow
disbursements $ (5,000)
$35,000 on its line of credit.
Cash Budget
(Collections and Disbursements)
April May June Total
Beginning cash balance $ 40,000 $ 30,000
Add: cash collections 170,000 400,000
Total cash available 210,000 430,000
Less: disbursements
Materials 40,000 72,300 Breakers must
Direct labor 24,000 36,800
borrow an
Mfg. overhead 56,000 76,000
Selling and admin. 70,000 85,000
addition $13,800
Equipment purchase - 143,700 to maintain a
Dividends 25,000 - cash balance
Total disbursements 215,000 413,800 of $30,000.
Excess (deficiency) of
Cash available over
disbursements $ (5,000) $ 16,200
Cash Budget
(Collections and Disbursements)
April May June Total
Beginning cashofbalance
At the end $ 40,000 has
June, Breakers $ 30,000 $ 30,000
Add: cash collections
enough cash to170,000
repay 400,000 335,000
Total cash available 210,000 430,000 365,000
the $48,800 loan plus interest at
Less: disbursements
Materials 12%. 40,000 72,300 72,700
Direct labor 24,000 36,800 24,000
Mfg. overhead 56,000 76,000 59,000
Selling and admin. 70,000 85,000 75,000
Equipment purchase - 143,700 48,300
Dividends 25,000 - -
Total disbursements 215,000 413,800 279,000
Excess (deficiency) of
Cash available over
disbursements $ (5,000) $ 16,200 $ 86,000
Cash Budget
(Collections and Disbursements)
April May June Total
Beginning cash balance $ 40,000 $ 30,000 $ 30,000 $ 40,000
Add: cash collections 170,000 400,000 335,000 905,000
Total cash available 210,000 430,000 365,000 945,000
Less: disbursements
Materials 40,000 72,300 72,700 185,000
Direct labor 24,000 36,800 24,000 84,800
Mfg. overhead 56,000 76,000 59,000 191,000
Selling and admin. 70,000 85,000 75,000 230,000
Equipment purchase - 143,700 48,300 192,000
Dividends 25,000 - - 25,000
Total disbursements 215,000 413,800 279,000 907,800
Excess (deficiency) of
Cash available over
disbursements $ (5,000) $ 16,200 $ 86,000 $ 37,200
Cash Budget Ending cash balance for
April is the beginning May
(Financing and Repayment) balance.

April May June Quarter

Excess (deficiency) of
Cash available over
disbursements $ (5,000) $ 16,200 $ 86,000 $ 37,200
Financing:
Borrowing 35,000 13,800 48,800
Repayments - - (48,800) (48,800)
Interest - - (838) (838)
Total financing 35,000 13,800 (49,638) (838)
Ending cash balance $ 30,000 $ 30,000 $ 36,362 $ 36,362

Interest Monthly Months Interest

Rate Borrowing Interest Rate Outstanding Expense
12% / 12 = 1% $35,000 1% 2 = $700
12% / 12 = 1% $13,800 1% 1 = 138
$ 838
Budgeted Income Statement
Breakers, Inc.
Budgeted Income Statement
For the Three Months Ended June 30
Revenue (100,000 $10) $ 1,000,000
Cost of goods sold 460,000
Gross margin 540,000
Operating expenses:
Selling and admin. expenses $ 260,000
Interest expense 838
Total operating expenses 260,838
Net income $ 279,162
Budgeted Statement of Cash Flows
April May June Quarter
Cash flows from operating activities:
Cash receipts from customers $ 170,000 $ 400,000 $ 335,000 $ 905,000
Cash payments:
To suppliers of raw material (40,000) (72,300) (72,700) (185,000)
For direct labor (24,000) (36,800) (24,000) (84,800)
For manufacturing-overhead expenditures (56,000) (76,000) (59,000) (191,000)
For selling and administrative expenses (70,000) (85,000) (75,000) (230,000)
For interest - - (838) (838)
Total cash payments (190,000) (270,100) (231,538) (691,638)
Net cash flow from operating activities $ (20,000) $ 129,900 $ 103,462 $ 213,362
Cash flows from investing activities:
Purchase of equipment - (143,700) (48,300) (192,000)
Net cash used by investing activities $ - $ (143,700) $ (48,300) $ (192,000)
Cash flows from financing activities:
Payment of dividends (25,000) - - (25,000)
Principle of bank loan 35,000 13,800 - 48,800
Repayment of bank loan - - (48,800) (48,800)
Net cash provided by financing activities $ 10,000 $ 13,800 $ (48,800) $ (25,000)
Net increase in cash $ (10,000) $ - $ 6,362 $ (3,638)
Balance in cash, beginning 40,000 30,000 30,000 40,000
Balance in cash. end of month $ 30,000 $ 30,000 $ 36,362 $ 36,362
Budgeted Balance Sheet
Breakers reports the following account balances on March 31
prior to preparing its budgeted financial statements for June
30:
Land - $50,000
Building (net) - $148,000
Common stock - $217,000
Retained earnings - $46,400
 25% of June Breakers, Inc.
Budgeted Balance Sheet
sales of June 30
$300,000
Current assets
11,500 kg at Cash $ 36,362
$.40 per kg Accounts receivable 75,000
Raw materials inventory 4,600
Work-in-process inventory 17,000
5,000 units at Finished goods inventory 23,000
$4.60 per unit. Total current assets 155,962
Property and equipment
Land 50,000
50% of June Building 148,000
purchases Equipment 192,000
Total property and equipment 390,000
of $56,800 Total assets $ 545,962

Beginning balance $ 46,400 Accounts payable $ 28,400

Add: net income 279,162 Common stock 217,000
Deduct: dividends (25,000) Retained earnings 300,562
Ending balance $ 300,562 Total liabilities and equities $ 545,962
Budget Administration

The Budget Committee is a standing

committee responsible for . . .
overall policy matters relating to the budget.
coordinating the preparation of the budget.
 Budgeting process
3 approaches to setting budget:

1. Top-down budgeting process

2. Bottom-up budgeting process

3. Negotiated budgeting process

 Top-down budgeting process / Imposed style of
budgeting

Top management set the overall goals for the budget period and prepares the budget
for the entire organization, including those at the lower operational level to achieve
these goals.

When imposed-budgets are effective?

1. In a newly-formed organizations
2. In a very small businesses
3. During periods of economic hardship
4. Operational managers lack budgeting skills
5. Different units in the organization requires
precise coordination.
Advantages:

1. Increase in the probability that the organization strategic plans are

incorporated into planned activities.
2. Plans and objective of divisions are coordinated.
3. Total resource availability is within management awareness
4. Avoid input from inexperienced and uninformed employees.
5. Time saving in budgets formulation and implementation.
 Disadvantages:

1. Dissatisfaction, defensive and low morale amongst employees.

2. No feeling of team spirit.
3. Limited acceptance of organization goal/objective
4. Arose the feeling of budget as punitive device.
5. No consideration of local operating environment.
6. Lower management initiative stifled
 Bottom-up budgeting process

The budgets are developed by the lower-level managers who will then submit the
budgets to the superiors. The budgets are based on the perception of what is
achievable (and the associated resources necessary) by those who are supposed to
carry out the budgets

Effective when:
1. Well-established organizations
2. Large Organizations
3. Period of economic affluence
4. Availability of strong skilled budget managers
5. Organization different units act autonomously
Advantages:

1. Information from employees most familiar to each units needs and

constraint is included
2. Knowledge spread among several level of management is pulled
together.
3. In general it is more realistic.
4. Improved in morale and motivation.
 Advantages:

5. Increased in commitment to organizational goal and objective.

6. Improved in inter unit coordination.
7. Development of operational plans tied to organizational goal and
objectives.
8. Specific resource requirement is included.
9. Good mixture of senior management overview with operational
details.
10. Provides an avenue of expression of expectation for both senior
and lower management
 Disadvantages:

1. Time consuming
2. Cause manager to introduce budgetary slack
3. Empire building
4. Require early start to budgetary process
5. Managers unqualified to participate might lead to unachievable
budget
 Negotiated Style Budgeting

Final budget are therefore most likely to lie between what top
management would really like and what junior managers believe is
feasible. The budgeting process is hence a bargaining process and it
is this bargaining process which is of vital importance, determining
whether the budget is an effective tool or simply a clerical device.
Behavioral Impact of Budgets
Budgetary Slack: Padding the Budget

People often perceive that their performance will look better in their
superiors eyes if they can beat the budget.
International Aspects of Budgeting
Firms with international operations face special problems when
preparing a budget.
1. Fluctuations in foreign currency exchange rates.
2. High inflation rates in some foreign countries.
3. Differences in local economic conditions.
End of LO1